Canadian oil sand, corporate exits, is this the end for the industry?

• Why there was a 62% decline in Canada’s oil and gas sector spending?
• Did domestic players help the sector?
• How crucial are the exports to the US?

Canada is one of the fastest growing oil producers in the world, in the past decade, the country saw a rise in the production at a CAGR ~4%. Canada managed to enhance its oil production from approx. 2.74 MBPD (2007) to 3.88 MBPD (during the end of 2016), while the latest production as per monthly figures between Jan.-Aug. stood around 4.01 MBPD. The nation’s oil reserves stand close to 171 billion barrels and make it the third largest player in the world in terms of reserves after Venezuela and Saudi Arabia.

Moreover, another aspect which differentiates Canada from the rest is its rich oil sand resources. ~96% of country’s reserves are from oil sands, the nation has consistently and structurally used technology to recover oil from sand. Furthermore, nearly all of this is located in the Alberta province in the country.

Presently, the oil industry which is one of the biggest contributors to the economy is not in good shape. Oil sands, which contain bitumen, a heavy and thick form of oil require complex refining process to convert this into normal form for usage. Hence, being heavy in quality with high content of impurities the conversion emits a considerable amount of greenhouse gases. This increases the investment both during extraction and refining as compared to the conventional oil exploration and refining. In the past few years, oil prices have declined significantly as benchmarked by WTI-NYMEX in the North American region, this also inflicted the oil industry in Canada. 

The major oil benchmark in Canada, the Western Canada Select has traditionally traded at an average discount of ~23% (last decade) at the WTI Cushing Spot due to its heaviness and sourness. Additionally, as WTI crashed in late 2014, the discount for Canadian oil at WTI further increased to ~27% (2015) and ~32% (2016). This weighed on the companies operating in the region. While falling global oil prices pushed down the investment from major players in the black liquid both with in Canada and globally. But the Canadian industry was additionally impacted due to high investments towards oil sands development. This resulted in a number of exits mainly from the oil sector.

Subsequently, since 2014 nearly USD 8 billion worth of asset sell-out occurred in the Canadian oil industry, majorly by foreign players. Additionally, around USD 2.6 billion worth of exits was witnessed in the first 7 months of 2017. Alberta region which is the major centre for the production of oil sands accounted for nearly USD 3.22 billion of transactions out of the total asset sale in the past few years. 

In addition, as a number of oil companies departed from the Canadian oil sand business recently, the conditions worsened due to deteriorating capital expenditures (growth and sustenance). According to the Canadian Association of Petroleum Producers (CAPP), spending in Canada’s oil and gas sector (conventional and unconventional) declined by CAD $50 billion or 62% since 2014, this was the largest 2-year fall from 1947 when CAPP and its predecessor organizations started tracking the data. CAPP’s April 2016 report added that the ‘total capital investment in the oil and natural gas sector is forecast to decline to CAD $31 billion in 2016, down from a record CAD $81 billion in 2014.’ The agency also estimated that the capital expenditure towards oil sands sector will decline in 2017 to approx. CAD $15 billion and this will be a fall for three consecutive years. 

Thus, as capital investments dried down and major foreign players continued to retreat from the industry, the only silver lining was the fact that domestic players were still existent. Nearly all the exits made by the foreign players were being compensated by the domestic players which seem to consolidate the sector in the long term. According to the consultancy firm, Wood Mackenzie, ‘over 70 percent of oil sands production is now concentrated among four Canadian producers, Canadian Natural Resources Limited, Cenovus, Imperial Oil and Suncor.’ In a positive development, few of these players have also announced expansion plans to enhance their oil production in the upcoming years.

A look at internals on crude oil production numbers in Canada shows that the total production is diversified into the light and heavy crude oil. According to the National Energy Board’s full-year data for 2016, the total production stood at 3.88 MBPD (Jan.-Jul. 2017 production stood at ~4.01 MBPD), this was almost equally divided into light and heavy oil. Similarly, bitumen based production from oil sands was 62.5% of the total output in 2016 (63.4% in Jan.-Jul. 2017 period) as equated to ~43% in 2007.  The output from oil sands consistently increased over the last decade with a CAGR growth of 8.3% as compared to ~4% of the total Canadian oil production. 

Consequently, as per the CAPP forecasts, the overall share of oil sands in the total production will further increase to around 70% (by 2020), while the total Canadian output is expected to increase up to 4.4-4.5 MBPD. Although there might be a downward revision to these projections as persistently weaker prices may weigh corporates to cap their overtly higher production, the industry will have to wait to see if a significant cut in production is announced or planned.

On the other hand, Canada exports a larger portion of its oil to the US. The Canadian oil exports to the US (incl. condensates though excl. other petroleum liquids) increased from approx. 1.88 MBPD (2007) to around 3.25 MBPD (2016), while presently, this roughly average 3.49 MBPD (Jan.-May 2017 period), taking total exports to production ratio close to 85%. Although, during the past few years the total US import numbers came down as its own production from shale plays improved. Yet, the US imported more oil from Canada than any other nation in the world. If this continues, the Canadian oil industry may not worry much despite the current downturn. 

Further, currently, the situation is not as bearish as is being projected for the Canadian oil industry and primarily for the oil sands sector. While there are sections in the oil and gas space which have written-off the oil sands play in Canada considering the huge number of exits in the past couple of quarters/years. Televisory believe that this is also acting as a positive development as the domestic industry continues to consolidate. Although until the prices improve and stabilize around the USD 45-50 per barrel mark for the Western Canada Select, the issues over profitability and execution would remain, though long-term horizon stays put for the industry. The saving grace is the consistent imports rise from the US, if this persists at the same pace, these would surely provide the much-needed padding for the oil sand industry in the present challenging times.

Major risk against Televisory’s view – oil prices persistently staying subdued and change in the US import policy

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